And after doing that, I’d plan an investment strategy to compound my investments to achieve the sum needed. My belief is it’s possible to achieve a passive income of £37,000 a year by compounding gains over time. And it’s possible to do so while earning an average salary and making regular investments in carefully chosen shares.
Targeting high dividend yields
My ultimate aim would be to invest a lump sum in dividend-paying shares and harvest an overall passive income of around 5%. And that’s because many UK shares are yielding at that level or higher right now.
For example, as I write, electricity network provider National Grid has a forward-looking yield a little above 5%. And supermarket retailer J Sainsbury is above 5.5%. Meanwhile, smoking products companies British American Tobacco and Imperial Brands are both looking ahead to yields around 7%.
But they’re not the only ones. Trading platform provider IG Group expects to yield almost 6%. And comparison website company Moneysupermarket.com is around 6% as well. Yet these stocks are only a few of the high-yielding companies listed in London.
However, the directors of any company have the full power to adjust shareholder dividend payments at will. And that means they sometimes trim them or stop them altogether if the business runs into operational difficulties. So, it’s important for me to carry out thorough research before investing in dividend shares for passive income. And to do that, I’d examine a company’s financial and trading record and aim to understand the opportunities and threats affecting the business.
Nevertheless, many companies have a fine multi-year record of paying shareholder dividends. So, I reckon it’s reasonable to assume I could achieve a 5% yield in dividends for my portfolio. And that means for passive income of £37,000 a year, I’d need to invest a lump sum of £740,000 in dividend shares.
Compounded annual gains
So that’s the target. And I’m encouraged by billionaire investor Warren Buffett’s observation. He pointed out that America’s S&P 500 index has delivered long-term compounded annual gains of around 10.5% with dividends reinvested. There’s no guarantee such performance will continue, but I see an index tracking fund following the S&P 500 as a decent vehicle for my quest.
For example, I could invest £500 a month into my tracker and reinvest all dividends along the way. It would then take around 26 years to accumulate the £740,000 I’d need. But that’s only if the index keeps up its rate of return in the years ahead.
However, I’d aim to get even better compounded annual gains by investing carefully into the shares of individual companies. Of course, such outperformance isn’t guaranteed. I could even lose money on shares if an underlying business runs into trouble.
Nevertheless, I’m determined to try. After all, Warren Buffett has managed almost double the performance of the S&P 500 and he’s investing billions.
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